It is a well-established fact that there is a correlation between an investment vehicle (such as a stock or a mutual fund) garnering media attention and capital flows into that investment vehicle (e.g. Sirri and Tufano 1998). But is this relation causal? Being mentioned in the news is, after all, related to having some news to report. Are observed capital flows a response to the underlying news about the investment vehicle, or to the media mention of this news? And even if investors respond directly to the media mention, do they respond to the information content encapsulated in it (i.e. to the news reported by the media) or do they respond to the mere mention of the investment vehicle?
Establishing a causal link from media mentions to investment flows has proven difficult due to the endogenous nature of media coverage and the omitted variable problem involved, though recent work has made some progress on that front. Determining whether this causal link is due to the information being conveyed or is merely caused by the attention directed at the investment vehicle has proven even more difficult.
In a new paper (Kaniel and Parham 2015), we exploit a clean natural experiment in which the Wall Street Journal has prominently published the top 10 mutual funds, ranked within various commonly used investment style categories, every quarter since 1994. Rankings are simply based on the funds’ returns during the previous 12 months, ensuring both minimal editorial impact and quasi-random assignment around the publication cutoﬀ (rank = 10). We use this setting within a regression discontinuity framework to demonstrate that:
- Media mentions cause increased capital flows;
- But only when these mentions are prominently placed;
- Even though the mentions convey no new information; and
- Mutual fund managers respond to the implicit incentive created by these increased flows, engaging in tournament behaviour to increase their chances of garnering media attention.
Media mentions and capital flows
Figure 1 graphically depicts a clear discontinuity in capital flows following publication between funds which appeared in the ranking (and thus garnered media attention) and those which did not. The figure presents mean capital flows into funds, during the quarter after publication, by fund rank, overlaid with two smoothed kernel regressions from both sides of the publication cutoff, and their 95% confidence bounds. The discontinuity, between funds ranked 11 (unpublished) and 10 (published), represents a 2.2 percentage point increase in flow of capital into the published funds during the post-publication quarter. This is a hefty 31% increase in capital flows (from 11 to 10), which is even more striking when considering the fact that the increase in returns between the two ranks is about 3% (or 0.6 percentage points). Importantly, a discontinuity exists only at rank 10 but not at any other plausible cutoff. The media effect on flows is roughly 7 times larger in magnitude than the effect of the well-documented performance-flow relation which shows that funds with higher performance garner more flows, as investors chase returns (e.g. Chevalier and Ellison 1997).
Figure 1. Mean capital flows into funds in quarter after publication, by rank
Note: mean capital flows into funds during quarter after publication by fund rank, overlaid with two smoothed kernel regressions from both sides of the publication cutoff, and their 95% confidence bounds
Hence, a clear causal relation exists between media attention and subsequent investor behaviour. This causal relation is supported by the fact that rankings around the publication cutoff are extremely fluid. For example, a fund which started the last day of a 12-month ranking period at rank 10 has more than a 25% chance of ending that day (and the entire 12-month ranking period) with rank > 10, and thus not being published. This is to say that published and unpublished funds are strongly randomly assigned around the cutoff, and the only notable difference between funds at rank 11 and at rank 10 is the media attention.
But is this effect the result of new information being conveyed? Or is it merely the prominence of the media mention that drives investment behaviour? Two other features of this natural experiment are helpful in answering these questions.
First, as the publication takes place during the first few days of the month following a 12 month period, all the information used to construct the rankings is already publicly available, such that any interested party can construct these rankings tables in advance of the publication. Hence, no new information is revealed in the publication.
Second, similar ranking tables were also published by the Wall Street Journal for within-quarter months (months that do not follow the end of a calendar quarter), but these rankings were not published in the Investing in funds - a quarterly analysis special issue, but rather less prominently in the back pages of the regular section of the newspaper, thus garnering much less media attention. Figure 2 repeats the analysis of Figure 1 for these within-quarter rankings and finds no discontinuity in capital flows. It is therefore evident that the prominence of the publication plays a critical role in investor persuasion.
Figure 2. Mean capital flows into funds in quarter after publication, by within-quarter rank
Note: mean capital flows into funds during quarter after publication by within-quarter fund rank, overlaid with two smoothed kernel regressions from both sides of the publication cutoff, and their 95% confidence bounds.
Fund managers’ response to incentives
The existence of a media effect on consumer financial decision making implies that fund managers’ payoffs resemble a call option due to the implicit asymmetric incentives induced by the extra flows. Discontinuity in capital flows implies that, for funds around the rank 10 cutoff, there is a greater upside to increased rank than a downside to decreased rank. For example, a fund ranked 11 a month before the end of a ranking period which drops from rank 11 to rank 20 by the end of the ranking period will, on average, see a 0.8 percentage point decrease in capital flows. Rising from rank 11 to rank 10 will, however, generate a 2.5 percentage point increase in flows. Do fund managers react to this implicit incentive, and if yes, how?
Consistent with theoretical predictions by Basak et al. (2007) and Cuoco and Kaniel (2011), funds ranked near the rank 10 cutoff at the beginning of the last ranking month, and only these funds, ‘diverge from the herd’ by increasing tracking error volatility relative to their category in an attempt to make the list. A closer analysis reveals that funds are well aware of the trade-offs induced by this risk shifting – within funds ranked near the cutoff, only those that are unlikely to be ranked as top performing funds next quarter increase tracking error volatility (and risk a performance decline relative to the category). Diverging from the herd is the optimal risk-shifting policy in such a tournament setting, and the fact that funds exhibit such a behaviour shows that:
- Financial intermediaries are aware of the existence of a media effect, and strategically react to it.
- Financial intermediaries are willing to take the risk of harming their performance to increase their chances of winning the tournament.
Furthermore, we show that ‘making the list’ (and garnering media attention) causes funds to increase advertising activity (in terms of average ad size, number of ads, and advertising expenditure), in an attempt to capitalise on the media attention. This is especially true for funds in the 6-10 rankings, which comprise the bulk of advertising in the quarter following publication.
Investors exhibit ‘limited attention’ behaviour, and react to ‘information-free’ media attention. Financial intermediaries predict this behaviour, and exhibit tournament behaviour to try and capture flows caused by media attention. These results fit well with the predictions of the model by Merton (1987), in which investors have a limited ‘consideration set’ of investments from which they choose, and when they hear of a new investment opportunity, they add it to the limited consideration set, rather than systematically searching for the investments most suitable for them.
Basak, S, A Pavlova and A Shapiro (2007) “Optimal asset allocation and risk shifting in money management”, Review of Financial Studies, 20: 1583–1621.
Chevalier, J A and G D Ellison (1997) “Risk taking by mutual funds as a response to incentives”, Journal of Political Economy, 105: 1167–1200.
Cuoco, D and R Kaniel (2011) “Equilibrium prices in the presence of delegated portfolio management”, Journal of Financial Economics, 101: 264–296.
Engelberg, J E and C A Parsons (2011) “The causal impact of media in ﬁnancial markets”, Journal of Finance, 66: 67–97.
Kaniel, R and R Parham (2015) “WSJ Category Kings: The impact of media attention on consumer and mutual fund investment decisions”, CEPR Discussion Paper, DP10923.
Merton, R C (1987) “A simple model of capital market equilibrium with incomplete information”, Journal of Finance, 42: 483–510.
Sirri, E R and P Tufano (1998) “Costly search and mutual fund flows”, Journal of Finance, 53: 1589–1622.
 Engelberg and Parsons (2011) demonstrate how extreme weather events which may disrupt the delivery of local newspapers sever the link between local content publication and local trading.